What Was the Market's View of U.K. Monetary Policy? Estimating Inflation Risk and Expected Inflation with Indexed Bonds

45 Pages Posted: 15 Oct 2006

See all articles by Eli M. Remolona

Eli M. Remolona

Bank for International Settlements (BIS) - Monetary and Economic Department

Michael Wickens

University of York; Cardiff Business School; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute)

Frank F. Gong

Bank of America - Bank of America, Hong Kong

Date Written: December 1998

Abstract

A measure of the credibility of monetary policy is the inflation risk premium in nominal yields. This will be time varying and can be estimated by combining the information in the nominal term structure with that in the real term structure. We estimate these risk premia using a generalized CIR affine-yield model, with one factor driving the real term structure of monthly observations on two-year, five-year and ten-year UK index-linked debt and two factors driving the term structure of the corresponding nominal yields. Our estimates show that the inflation risk premium contributes on average about 100 basis points to nominal yields. Since the exit from the ERM this has fallen to 70 basis points, showing greater policy credibility. The inflation risk premium provides a correction to the break-even method of forecasting inflation and produces an unbiased forecast.

Keywords: inflation risk, expected inflation, indexed bonds, affine yields and monetary policy

JEL Classification: E31, E43, E62, G12

Suggested Citation

Remolona, Eli M. and Wickens, Michael and Gong, Frank F., What Was the Market's View of U.K. Monetary Policy? Estimating Inflation Risk and Expected Inflation with Indexed Bonds (December 1998). FRB of New York Staff Report No. 57, Available at SSRN: https://ssrn.com/abstract=937350 or http://dx.doi.org/10.2139/ssrn.937350

Eli M. Remolona (Contact Author)

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

IFC 2 Bldg, 78/F
Central
Hong Kong
Hong Kong
+852 2982 7150 (Phone)
+852 2982 7123 (Fax)

Michael Wickens

University of York ( email )

Heslington
York, YO10 5DD
United Kingdom
+44 1904 433 764 (Phone)
+44 1904 433 575 (Fax)

Cardiff Business School ( email )

Centre for Economic Policy Research (CEPR)

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Frank F. Gong

Bank of America - Bank of America, Hong Kong

Hong Kong
Hong Kong

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